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Wednesday December 15, 2004 - 22:12:13 GMT -

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Forex: Dollar Tanks As Foreign Inflow Falls Short Of Meeting Deficit Needs

DailyFX Forex Fundamentals 12-15-04

By Kathy Lien, Chief Strategist of

· Dollar Tanks As Foreign Inflow Falls Short Of Meeting Deficit Needs
· British Pound Rises On Stronger Employment Data
· Business Sentiment Declines In Japan


There was good reason for the euro to rally against the dollar today. With the market fixated on the US deficits, the shockingly weak Treasury International Capital flow data gave dollar bears ample reason to rally the single currency back above 1.34. According to the October report, there was not enough foreign investment to meet the trade deficit for the same period. Net long-term flows fell to $48.1 billion from $67.5 billion in September. The trade deficit for the same month was $55.5 billion, which was a shortfall of $7.4 billion. Of most concern was the fact that the Japanese also sold US treasuries for the second consecutive month, while China slowed their purchases from $2.1 billion to $300 million. Deterioration in the value of their treasury holdings and diversification of reserves are both valid reasons for waning Asian demand. Last month, we said that one month does not make a trend and two months may be too early to term it that as well. However, demand from Asia is something that we are monitoring very closely, as it would provide an even stronger case for a dollar correction. If this continues, the “dollar dumping” that we have been talking about for some time will become an even alarming issue. Although we are still anticipating the current account balance tomorrow and CPI on Friday, judging from today’s price action, we are still trapped in the 1.3200-1.3400 trading range, which may very well persist into the holidays.


Although the Treasury International Capital flow data unnerved the markets, we did see evidence of strength in the overall economy. The Empire state manufacturing survey soared from a downwardly revised 18.86 to 29.93. The market had expected activity to increase only marginally. Improvements were seen in employment, new orders, shipments and unfilled orders. The NAHB housing market index also remained unchanged at 71 (the market had expected a deterioration to 70), indicating that the housing market is still resilient despite a series of interest rate hikes. Tomorrow’s quarterly current account data holds less importance since we already know that the deficit will be widening and that it is becoming increasingly difficult for the US to attract foreign investment. Elaborating on the TIC data, although foreigners have cut back holdings of US assets, US investors have hungrily consumed foreign investments, increasing their purchases from $2.7 billion to $15.2 billion in October.


Rising ever closer to 13-year highs, the British pound climbed on better than expected employment reports released during the overnight session. With consumer prices rising by 1.5 percent earlier this week, inflationary pressures may be looming as a government report showed wage earnings rose in the three months through October. Wages excluding bonuses climbed 4.4 percent, the fastest rate since March 2002 and well in line with previous estimates. Coupled with a significant drop in the number of people claiming unemployment, the report showed the unemployment rate remained constant at 2.7 percent as gains in hires of teachers and nurses kept the rate at its lowest in 29 years. Unemployment benefit claims dropped 3,400 to 836,600 in November with most economists expecting a decline of 300. With the labor market tight and economic growth racing forward for 49 consecutive quarters, further wage growth seems imminent. As a result, higher labor costs and rising raw material prices may contribute heavily to building inflationary pressures.


The Japanese yen has strengthened significantly against the US dollar. Greenback fundamentals dominated price action in the pair as the yen rallied despite weaker Japanese business sentiment and rising oil prices. For the first time in seven quarters, business sentiment deteriorated as a result of slower production and weaker exports. However, it is not all bad news since the decline was off of a 13 year high and the capital spending outlook remains healthy, which means that the recovery could still be in place, although there are clear signs that we have hit soft patch. The latest leading economic indicators report also confirms slower growth. Encouragingly, large firms have also revised their sales forecasts higher. The survey was completed before December 1st and they were based upon a predicted average USDJPY rate of 106.31, compared to 106.12 from the previous quarter.


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